An extract from The Oil and Gas Law Review - 7th edition

Introduction

The Republic of Iraq, including the Kurdistan Region of Iraq (KRI), is a country vested with many easily exploitable oilfields. The exploration and production of oil in Iraq started as early as the 1920s. The Iraqi oil sector was fully nationalised in 1975. After several years of war and sanctions, Iraq, against the backdrop of its post-conflict setting, besieged by competing political, ethnic and sectarian factions, corruption and turmoil, aims to replace the former state monopoly on oil and gas with private development.

The KRI has been particularly successful in this regard. Starting oil and gas activities only in 2006, the Kurdistan regional government (KRG) concluded more than 50 production-sharing contracts (PSCs) with international oil companies (IOCs). Initially the contracting partners were minor oil companies such as Gulf Keystone, Genel and Western Zagros. Gulf Keystone discovered the giant Shaikhan field with 14 billion barrels of oil in place (subsequently adjusted downwards). It was one of the world's largest onshore discoveries in more than 20 years. In 2012, ExxonMobil pioneered as the first major IOC, followed by Chevron, Total and Gazprom.

The Kurdistan Region Ministry of Natural Resources (MNR) estimates the reserves at 45 billion barrels of oil and at 25 trillion cubic feet (tcf) of proven gas reserves and up to 198 tcf of largely unproven gas. If the KRI were an independent country, the amount of oil and gas reserves would place it among the top 10 oil-rich countries in the world. However, the region is still an integral part of the Republic of Iraq even though it enjoys semi-autonomy.

Both the KRG and the central government in Baghdad remain at odds over the authority to administer and dispose of oil being produced in the KRI at a current estimated production level of 426,000 barrels per day (bpd). In the course of these quarrels, the central government has repeatedly withheld the payments of federal budget portions allocated to the KRI. In turn, the KRG continued and expanded its independent oil exports to Turkey. The low world market oil prices and the Kurdish peshmerga's and Iraqi army forces' fight against the terrorist group ISIS created a severe financial crisis in the KRI.

In 2016, owing to the strained financial situation of the KRI, the central government and the KRG again began to jointly export crude oil from the Kirkuk fields to Ceyhan in Turkey. The parties continued negotiations to finally reach a comprehensive revenue-sharing deal involving the entire oil and gas reserves of Iraq but with little success.

In 2017, and after three years of ISIS controlling huge swathes of land in northern Iraq, Mosul, the last major stronghold of ISIS in Iraq was liberated, and the existence of ISIS in northern Iraq has been substantially reduced. However, this has unfortunately not resulted in the desired stability to the region and Baghdad and the KRI remain at odds over the regions' oil reserves and the rights of the KRI to export crude oil independently of Baghdad and SOMO, the Iraqi oil marketing organisation.

Following a very rocky 2016, where the KRI was behind on payments to major IOCs, and involved in major military operations to liberate Mosul, in 2017 the KRI took major steps to remedy the situation and bolster confidence in the KRI from the IOCs and the international community. Most importantly, settlement agreements were reached with several IOCs. Further, agreements were entered into with Russian Rosneft, despite objections from Baghdad, to manage and develop the Turkey pipeline in addition to agreements for cooperation in the entire hydrocarbons production chain including exploration and development of five blocks, production and logistics. Rosneft further agreed to finance Kurdish crude oil. A new deal was signed in early 2018 focusing on developing the gas sector in the KRI, including a new gas pipeline. Furthermore, Rosneft will reportedly start geological explorations in the KRI later in 2019.

On the political front, the KRI, after its leading role in liberating both Kirkuk and Mosul and its apparent successes in the oil and gas sector, held a referendum for independence on 25 September 2017. The positive outcome was at the very least expected to give the KRI additional footing and leverage in any future negotiations with Baghdad regarding oil and gas in the Kurdish-controlled regions of northern Iraq, especially given the supportive stance of Kirkuk. However, soon after the referendum, Iraqi forces retook Kirkuk and control of the oilfields from the Kurds, cutting the KRI's revenues nearly by half. Losing control over the oilfields meant reliance on Baghdad for income once again.

Exports from Kirkuk were halted after the post-referendum military offensive by the central Iraq forces, which then diverted outputs to local refineries. On 16 November 2018, exports from Kirkuk to the Ceyhan pipeline resumed. The central government exported up to 105,000bpd in June 2019 from Kirkuk, most of which was transported via Ceyhan. There have been ongoing discussions for months regarding the security and military situation in Kirkuk, and although there has been some cooperation over the past year, the Kirkuk issue still remains to be resolved. Adding to the tensions is the KRG's failure to contribute 250,000bpd to the central government in exchange for its share of the federal budget as agreed in the 2019 budget. As of July 2019, there had been attempts by a faction of the Iraqi parliament to amend the 2019 budget and cut transfers to the KRG if the latter does not deliver the required amount of oil. However, this garnered few votes, and the KRG will receive a limited budget allocation regardless of whether it abides by its obligation or not, as the 2019 budget law appears to be more lenient than previous annual budgets in this regard.

In 2012, the central government filed a case against the KRG challenging the latter's independent oil exports. The case was continuously postponed owing to a procedural loophole that prevented the court from hearing the case without the attendance of a KRG representative. This finally changed in April 2018 when the KRG attended the court. Since then, proceedings have been slow and the ruling constantly delayed, with the most recent delay owing to a missing signature from the Iraqi Prime Minister Adil Abd al-Mahdi on revising filings submitted to court.

Amidst internal conflict between the different Kurdish political parties resulting from many factors, including the independence referendum, former KRI president Masoud Barzani's resignation on 29 October 2017, the financial difficulties and the disputes with central government amongst others, the KRI held its parliamentary elections in September 2018. No single party won the majority of the Kurdish parliamentary seats. At the same time Mr Barham Salih was elected the president of Iraq. More recently, the Kurdistan Parliament elected former KRI Prime Pinister and Masoud Barzani's nephew, Nechirvan Barzani, as President of the KRI on 28 May 2019, and Masoud Barzani's son, Masrour Barzani, as Prime Minister on 10 June 2019. Both have expressed their determination in helping to improve relations between the KRG and central government.

Legal and regulatory framework

Iraq's legal framework for the petroleum industry is quite ambiguous. Pursuant to the Iraqi Constitution, 'oil and gas are owned by all the people of Iraq in all the regions and governorates'. However, the exploration and production of oil and gas are not governed by the Iraqi Constitution. It only states that 'the central government, with the producing governorates and regional governments, shall undertake the management of oil and gas extracted from present fields, provided that it distributes its revenues in a fair manner in proportion to the population distribution in all parts of the country . . . and this shall be regulated by a law.'

The Iraqi Constitution only refers to 'present fields' where the management of present fields falls under the shared jurisdiction, while the management of other oil and gas resources that are not 'present fields' are not expressly addressed in the Constitution. Nonetheless, the term 'present fields' does not reflect common concepts of the oil industry such as 'proven – probable – possible', 'developed – undeveloped' or 'producing – non-producing'. That said, the KRG maintains that present fields within the meaning of the Iraqi Constitution refers only to the oil and gas fields that were producing at the time of enactment of the Iraqi Constitution in 2005. All other oil and gas resources (i.e., fields not producing or even not discovered in 2005) are not encompassed. The KRG takes the position that non-producing fields (as of August 2005) do not fall within the shared jurisdiction of the central government and the KRG, and, therefore, the KRG has exclusive jurisdiction over such fields. Hence, the KRG regards itself as the competent authority to regulate all oil and gas resources in the Kurdistan region other than 'present fields'. The central government in Baghdad rebuts this interpretation of the Iraqi Constitution and believes that the KRG lacks the requisite constitutional authority to sign contracts with foreign oil companies, which it deems illegal.

Pursuant to Article 112(1) of the Constitution, the foregoing varying interpretations should have been regulated by a law creating a comprehensive and fair framework for the management of the Iraqi oil and gas sector, including the rights and competencies of the governorates and regions to have an active role in the management and a share of the revenues. For years, the KRG and the central government failed to agree on a unified federal oil and gas law in implementation of the Iraqi Constitution. Finally, in 2018, a new Iraqi National Oil Company Law No. 4/2018 (the INOC Law) was passed by the Iraqi parliament and came into force in April 2018. While the INOC Law contains some provisions that appear to implement some of the requirements of the Constitution and to liberate the oil and gas sector, the INOC Law is far from a federal oil and gas law as envisioned by the constitution as it does not address in any detail the management and cooperation between the central government and the KRG with respect to oil and gas from present or future fields. The INOC Law was immediately challenged on the basis of the constitutionality of some of its provisions. In January 2019, the Federal Supreme Court found that a number of the INOC Law provisions were unconstitutional, effectively rendering the INOC Law impossible to implement without first amending or replacing the unconstitutional Articles.

A decision of the Federal Supreme Court is also pending in the proceedings initiated by the central government in 2012 challenging the KRG's right to independently export crude oil from the KRI. In 2014, the court refused to grant the Federal Ministry of Oil an injunction against the KRG prohibiting it from exporting crude oil independently on the basis 'that [granting such an injunction] would give an impression of a premature decision on the subject matter of the proceedings and the decision that shall be issued by the court' which would contravene the judicial “context/norms” '. The final decision of the Federal Supreme Court on the matter, whether positive or negative will have far reaching implications on the oil and gas landscape of the KRI and Iraq as a whole.

i Domestic oil and gas legislation

The Iraqi Constitution gives the regions the right to legislate on any matters that do not fall within the exclusive jurisdiction of the central government and, pursuant to the Kurdistan National Council (the predecessor to the current Kurdistan parliament) Decision No. 11/1992, federal laws passed after 1992 are not applicable in the KRI unless specifically adopted pursuant to a KRI law. The Constitution further provides that where a conflict exists between a federal law and a regional law, the regional law shall prevail.

Premised on the foregoing, in 2007 the KRI legislator passed its own Kurdistan Oil and Gas Law – No. 22/2007 (KOGL). The KOGL applies to all petroleum operations in the KRI. No federal legislation, and no agreement, contract, memorandum of understanding or other federal instrument that relates to petroleum operations, applies in the KRI except with the express agreement of the relevant authority of the KRG. Hence, the federal Iraqi legislation and regulations with respect to petroleum operations is not applied in the KRI.

The MNR oversees all oil and gas matters in the KRI. The Minister of Natural Resources may license petroleum operations (i.e., activities including prospecting, exploration for, development, production, marketing, transportation, refining, storage, sale or export of petroleum; or construction, installation or operation of any structures, facilities or installations for the transportation, refining, storage, and export of petroleum, or decommissioning or removal of any such structure, facility or installation) to third parties after approval of the Regional Council for the Oil and Gas Affairs of the Kurdistan Region – Iraq (the Regional Council) (which consists of all relevant ministers of the KRG's cabinet identified in Section II.ii). The MNR shall encourage public and private sector investment in petroleum operations.

The central government in Baghdad asserts that the KOGL, as well as all petroleum contracts entered into by the KRG, including PSCs as well as the recent Rosneft agreements, are unconstitutional and, therefore, invalid. Based on this position, the central government has in the past repeatedly refused to pay the KRG the full share of the oil revenues generated by SOMO and stopped payments to the KRG altogether in April 2014. Negotiations to finally settle this ongoing dispute continue.

In April 2013, the KRI adopted the 'Law of identifying and obtaining financial dues to the Kurdistan Region – Iraq from federal revenue' (the Financial Rights Law). The Financial Rights Law grants the KRG the right to independently export crude oil produced in the KRI if the central government fails to pay the KRG its share of revenues (including oil revenues), budget items, other national allocations and reparations. However, the central government denounces independent Kurdish oil export as 'smuggling'. Prior to the enactment of the INOC Law, the central government took the view, based on its interpretation of the Iraqi Constitution and existing federal legislation, that SOMO has the sole authority to sell hydrocarbons internationally and all oil proceeds must be deposited with the Development Fund of Iraq (DFI) established pursuant to United Nations Security Council Resolutions (UNSCR), including UNSCR No. 1483 and in accordance with Section 5(1) of the Financial Management Law (CPA Order 95). The DFI was originally administered by the CPA but has since transferred to the federal Minister of Finance, reporting to the Council of Ministers, which shall take advice from the governor of the Central Bank. Article 3 of the INOC law, which permitted the INOC to sell hydrocarbons and to remit profits to the state treasury, not the DFI, has been found to be among the provisions of the INOC Law that the Supreme Court has held to be unconstitutional. Furthermore, based on the 1992 KRG Decree and the fact that oil and gas management and revenues are not captured by the exclusive authorities of the central government as provided in the Constitution, the KRI does not recognise the INOC Law as applicable to the KRI.

In the meantime and notwithstanding the constitutionality or lack thereof of the INOC Law, the central government had initiated several legal proceedings prior to the enactment of the INOC Law against entities involved in the independent export and sale of oil produced in the KRI, including the government of Turkey and its state-owned pipeline operator BOTAS, and several shipping companies. These actions by the central government have severely raised the risk assessments by many players in the market and scuttled many other intended oil sales by the KRG.

Based on the foregoing and the KRG's continued autonomous sales of hydrocarbons despite objections from the central government, the KRI's parliament passed the Kurdistan Oil and Gas Fund Law No. 2/2015 (KOGFL) pursuant to the KOGL. The KOGFL provides for the establishment of a monetary fund (the KOG Fund) to be managed by a board appointed by the KRG Council of Ministers after an absolute majority approval of the parliament. All proceeds from any hydrocarbon activity in the KRI or related to that activity, including allocations from the federal budget that are directly attributable to hydrocarbons, are to be deposited with the KOG Fund. Monies accounted for in the KOG Fund are to be remitted to the KRG Ministry of Finance to be spent in accordance with the KRG Budget. In addition, under the KOGFL monies in the fund shall be distributed according to the KOGL and with specific allocations to a 'future generation fund' to be established, to the KRG budget, the social security fund, the agricultural infrastructure fund and the environment fund, as well as a US$2 per barrel allocation for each province from which the revenues were derived.

ii Regulation

The regulatory agencies competent for overseeing upstream oil and gas activities in the Kurdistan region are:

  1. the Iraqi Kurdistan parliament: the Kurdistan parliament is the legislative body of the KRI and passes its laws;
  2. the KRG: the KRG governs the KRI in accordance with the laws enacted by the Kurdistan parliament;
  3. the Regional Council: the Regional Council consists of the Prime Minister, the Deputy Prime Minister, the Minister of Natural Resources, the Minister of Finance and Economy and the Planning Minister; it mainly formulates the general principles of petroleum policy, prospect planning and field development and approves petroleum contracts; and
  4. the Ministry of Natural Resources of the Kurdistan Region: the MNR oversees and regulates all petroleum operations in the KRI and it negotiates and signs PSCs on behalf of the KRG jointly with the Prime Minister representing the Regional Council.

Other agencies and ministries such as the Social Security Directorate, the Residency Directorate and the Ministry of Agriculture and Water and Irrigation have regulatory oversight for their areas of competence that fall within the activities of IOCs operating in the KRI.

iii Treaties

Pursuant to the Iraqi Constitution, the central government in Baghdad has the sole authority to sign and ratify international treaties and agreements.

Iraq has signed several investment and other bilateral agreements with India, Iran, Japan, Jordan, Kuwait, Mauritania, South Korea, Sri Lanka, Syria, Tunisia, Turkey, the United Kingdom, Vietnam and Yemen, among others, some of which have not yet come into force as they are pending ratification by the Iraqi Council of Representatives. In addition, Iraq has entered into bilateral free trade agreements with the United Arab Emirates, Oman, Qatar, Algeria, Egypt, Jordan, Lebanon, Syria, Tunisia, Yemen and Sudan. In 2010, Iraq concluded bilateral investment treaties with France, Germany, and Italy. The bilateral investment treaties with France and Germany were ratified by the Iraqi Council of Representatives in 2012. As far as we are aware, the treaty with Italy has not yet been ratified.

On 11 July 2005, Iraq and the United States penned a Trade and Investment Framework Agreement. The Iraqi government ratified the agreement in December 2012. The aim of this agreement is to promote and facilitate investment and trade between the two countries. At present, the United States does not have a bilateral investment treaty with Iraq.

With regard to judicial cooperation and dispute resolution, Iraq, including the KRI, is a signatory state of the Riyadh Arab Agreement for Judicial Cooperation of 1983 (the Riyadh Convention). According to the Riyadh Convention, each contracting party shall recognise the judgments made by the courts of any other contracting party in civil cases having the force of res judicata and shall enforce them in its territory. Nonetheless, judgments made against the government or against any of its employees in respect of acts undertaken in the course of duty or exclusively on account thereof are exempted. The same applies to awards of arbitrators.

In December 2012, the website of the Iraqi Council of Representatives announced that the Council of Representatives had ratified the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (the ICSID Convention). The ICSID Convention entered into force in Iraq on 17 December 2015.

On 6 February 2018, Iraq officially voted in favour of accession to the 1958 New York Convention, which applies to the recognition and enforcement of foreign arbitral awards. However, it has yet to be approved by the Iraqi parliament.